NEW DELHI: Bond yields are on the rise and, among other factors, they are threatening equity returns. On Monday, India’s 10-year bond yield rose 1.17 per cent to 6.20. It was ruling at sub-6 per cent level before the Budget, but has risen since, thanks to higher government borrowing targets for remainder of FY21 and also for FY22.
A sharp rise in bond yields so far has widened their gap with earnings yields, making stock investment unattractive.
The relation between the two is defined by the BEER ratio, or bond-earnings yield ratio, which is calculated by dividing the benchmark 10-year bond yield by the earnings yield of the stock market or the benchmark index.
On Monday, FY22 Nifty P/E stood at 22 times resulting in an earnings yield value of 4.54 (1/forward PE multiple or EPS/price). And that gives a BEER ratio of 1.36. A value above 1 suggests equities are overvalued.
For this ratio to come down, either bond yields need to drop or earnings yield needs to rise.
“The next few months would be a bit challenging, not just because of interest rates. We also have to face the pressure from rising raw material costs, which are going to have its own impact on profitability. Also, over the next one or two quarters, it will be clear whether what we witnessed in terms of very strong momentum in December quarter earnings was a mix of pent-up demand and how much of that tailwind actually goes off and how much of the growth sustains,” Vinit Sambre of DSP Mutual Fund told ETNOW.
Analysts said the bond market is nervous and market might be seeing short selling. They said market participants were hoping that RBI would guide the market with some sort of a calendar for open market operation (OMO) for the bond purchase program for next year. But the central bank has refrained from doing that so far.
SBI Economic Research said RBI can consider conducting large scale open market operations (OMOs) to provide necessary steam to the bond market to rally, and with increase in price, many short sold positions will trigger stop losses and market players will scramble to cover open positions.
“This will lead to a rapid fall in yields over a short period of time,” it said.
Globally also, bond yields are rising in the developed market on the hope of a rise in inflation.
“If inflation were to rise, central banks would take a pause and may go back and hike or look at some other ways of reducing the liquidity in the system, which might impact the flows to equity. So, it is a kneejerk reaction right now. However, as the earnings recovery has just started, both globally as well as in India, we expect the earnings momentum to continue over the next three-four years. This is just the beginning of the earnings growth cycle,” said Siddhartha Khemka of Motilal Oswal Securities.
Madhavi Arora is Lead Economist at Emkay Global Financial Services said while lower yields did help equities post the Covid peak, market may not necessarily de-rate if yields go up now. “In fact, just ahead of the crisis, the 10-year US yield was close to 2%, and the equity market was pretty happy against that backdrop. A study of upcycles of bond yields (50bp+) in the past 10 years showed equities were up almost 100% of those upcycles, except for the Covid period.”
She, however, added that the fortunes of emerging markets were somewhat mixed on those occasions, especially when that involved a stronger US dollar.